OzForex: Result 2016

The payments specialist has reported a fall in earnings, and the outlook isn't much better for this year – but what matters for the stock is what happens after that.

You might have thought it was just the banks in the firing line for Australia’s recent spate of big name insolvencies, but it turns out that Dick Smith used OzForex for its international payments and has left it out of pocket to the tune of $300,000.

The bad luck didn’t stop there in the payments specialist’s latest full-year results. A ‘significant’ new white label partner apparently pulled out at the last minute due to the takeover discussions held with Western Union. Media reports suggest the potential partner was a competitor of Western Union, so it’s understandable that they would pull out.

Key Points

  • Earnings in line with guidance

  • Margins to fall in 2017

  • Rebranding on track

With all this going on in the background, then, it was probably with some relief that chief executive Richard Kimber announced underlying earnings before tax, depreciation and amortisation (EBTDA*) of $36.1m – right in the middle of the guidance given in February alongside the collapse of the takeover talks.

The problem highlighted in February was that the flow of new customers had dried up since the company stopped promoting the OzForex brand ahead of the launch of the new OFX brand. This was certainly evident in the result, with the number of active clients growing only 6% to 151,000, compared to an 18% increase in net operating income. Of course it also meant that promotional costs rose only 9% to $15.2m, although this was more than offset by a 26% rise in employee costs to $38.2m as the group took on staff to implement its plan to double revenue by 2019.

Table 1: OzForex 2016 result
Year to March ($m) 2016 2015 /(–)
(%)
Trans. value 19,600 16,600 18
Fees & comms 111.2 95.6 16
Trans. costs (9.0) (7.3) 23
Net fee inc. 102.2 88.3 16
Net interest 1.7 1.8 (6)
Net op. income 103.9 90.1 15
U'lying EBTDA 36.1 34.5 5
U'lying net profit 23.9 24.3 (2)
U'lying EPS (c) 9.8 10.0 (2)
DPS (c) 6.7 7.1 (6)
Final dividend 3.1c, fully franked, ex date 8 Jun

Ad campaign

Mass market advertising of the new OFX brand finally began in Australia two weeks ago, with the US and UK to follow within weeks. As a result, management is expecting promotional costs to increase by 33% in 2017. This will initially result in lower margins and most likely a fall in EBTDA in the first half of 2017, although management said it expected full-year 2017 EBTDA to be higher than 2016, ‘with accelerating growth into FY18’.

Where exactly margins and profits end up over the next half or two is of little significance. Management could boost margins at any stage by lifting its foot off the marketing pedal, but we hope it doesn’t. The rebranding is the right thing to do and the outcome of an investment in OzForex will depend on its success or failure.

It is of course very early days, but Kimber seemed pleased with initial results. Unique visitors to the Australian site have risen 44% since the advertising campaign began two weeks ago (you might have seen the ads following you around the internet). This, Kimber added, had flowed through into new registrations and new customers.

The new sites have already been running in the background for a few months, building their quality scores with search engines. The various country-specific sites will also benefit from using the same root url – www.ofx.com – so there should be a ‘snowball effect’ as other new sites are promoted.

Broadening the market

The ‘mass-market’ advertising is a new departure for OzForex, which has traditionally focused on search engine optimisaton and marketing. This is probably partly a response to the heavy advertising by competitor TransferWise. However, chief financial officer Mark Ledsham said they’d broadened their target market because of research they'd done suggesting that half the people planning an international payment just head to the bank without actively searching for alternatives.

Either way, it neatly demonstrates the benefits of advertising in under-developed rather than mature markets: the money spent actually grows the market for everyone rather than just defending market share.

If we conservatively assume flat underlying earnings per share for 2017, that would put the stock on a price-earnings ratio of about 22. That doesn’t look particularly cheap for a stock that won't have shown much growth for a couple of years. As we’ve already noted, though, this year’s earnings are largely a matter of how much management wants to invest in the new brand. We hope and expect the answer to that to be plenty.

As a guide to the potential beyond that, if management succeeds in its plan to increase revenue to $200m in 2019, then at 2015 margins, OzForex would make a net profit of about $54m. That would imply earnings per share of about 22 cents and give a 2019 price-earnings ratio of about 10.

With a large range of potential outcomes, the stock is risky, but for those prepared for that it remains a HOLD.

* OzForex holds significant amounts of client cash while waiting to settle deals. As a result, interest forms an important part of its operating profit, so it uses ‘earnings before tax, depreciation and amortization’ as a reporting measure rather than the more common ‘earnings before interest, tax, depreciation and amortisation’.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in OzForex. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in OzForex.